March 12, 2014

Bankruptcy & Bitcoin: Mt. Gox Follow-Up

by Kim Schmittel

I thought I would chime in with a couple of points following up on my original bitcoin/bankruptcy article, available here. Part I went up at the end of February, right after a major exchange -- Mt. Gox -- had filed an insolvency proceeding in Tokyo.

Things move fast in bankruptcy-land and even faster in bitcoinland. Here's a timeline of recent events:

February 28 -- Mt. Gox files bankruptcy in Japan

March 9 -- Mt. Gox's US affiliate files Chapter 15 in Dallas, TX. Yesterday, Weil's bankruptcy blog had a comprehensive post about the US proceeding yesterday, including what a Chapter 15 is and what strategy benefits it may offer an international debtor. One of those benefits is the domestic debtor's ability to seek extension of Section 362's automatic stay to cover the domestic debtor, via Secion 1521(a)(7).

March 10 -- the Dallas Court entered this order provisionally extending the automatic stay to the US debtor, and setting a recognition hearing for April 1-2.

March 11 -- in a class-action pending in the Northern District of Illinois, Judge Feinerman entered a TRO freezing the US assets of Mark Karpeles, Mt. Gox's CEO. The automatic stay, even as applied through Chapter 15, doesn't apply to non-debtor entities or executives.

So what's next? Can we expect the class action plaintiffs to wage an overt turf-war on the Chapter 15, and object at the recognition hearing in April? As Reuters reported from the TRO hearing:

"This case involves a massive fraud," said Steven Woodrow, an attorney leading the class action, told Hale. "They claim incredibly that they will preserve assets and protect assets by entrusting the servers and other property to Mr. Karpeles. Respectfully, your honor, that is the definition of the fox guarding the henhouse."

We'll see. Woodrow's statement that internal fraud may be behind the exchange's insolvency is something that is widely-believed in the bitcoin community as well (judging solely from my own wholly-unscientific review of forum-screaming). Gox and Karpeles continue to invite this kind of skepticism because they continue to blame the Bitcoin protocol itself for the mess. From Karpeles' declaration in the Chapter 15:

The cause of the theft or disappearance [of 744,408 bitcoins] is the subject of intensive investigation by me and others -- as of the present time I believe it was caused or related to a defect or "bug" in the bitcoin software algorithm, which was exploited by one or more persons who had "hacked" the bitcoin network.

The bitcoin community this explanation as insulting and technically impossible, and concludes that there must be fraud behind the scenes. However much sense that makes, it seems awfully hard to prove under the circumstances. Moreover, recognition in a Chapter 15 is typically mechanical and tough to defeat if the mechanical elements are satisfied. However, Mt. Gox is anything but a typical case, and there is an exception if recognition is "manifestly contrary to the public policy of the United States" under Section 1506. Could, instead, the Chapter 15 debtor try to extend the stay even further to cover Karpeles (like a major Chapter 11 debtor might do using Section 105 to cover its executives)?

There are lots of interesting possibilities, and we'll know more in April.